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Thursday, May 4, 2017

MARKET OUTLOOK: Eurozone Is Doing Better Than The US.

The dollar is softer this morning despite the Fed saying yesterday the recent slowdown is “likely transitory” and the Fed is still on track for two more hikes this year. The probability of the June hike in the CME FedWatch indicator rose to 71.8% last evening from 66% before the Fed statement (but 69.1% at 6:20 am today). Bloomberg got 94% late yesterday. The dollar index jumped 2% higher on the 2 pm announcement but gave back much of the gain by this morning and is down 0.30% (from 99.26 at the close to 98.96).

Against the yen, the dollar hit a 6-week high and after a dip during the Asian session, resumed its rise to 113.02 by 6:30 am ET. But the euro, after freaking out in the US afternoon to a low of 1.0888 and further in Asia to 1.0873, recovered smartly and is now testing upside resistance.

Yields rose in every tenor except the 30-year. At the short end, the 3-month and 6-month closed at the highest yields since Oct or Nov 2008, according to the WSJ. The 2-year yield settled at 1.296%, the highest since March 28. “The 30-year bond was the only maturity whose price strengthened on Wednesday. The yield fell to 2.955% from 2.982% Tuesday.” The setback arose because the Treasury’s Borrowing Advisory Committee determined that there is no “evidence of strong or sustainable demand for maturities beyond 30 years.”

The other big news of the day came earlier when ADP released its private sector employment forecast at 177,000 jobs in April. Recall that March was 89,000 for both sectors. And the ISM service sector PMI rose to 57.5 from 55.2, the best reading in 18 months.

In other markets, gold fell 1% to under the 200-day moving average. Other commodities are suffering, too, with copper down 3.5% on a rise in stockpiles, nickel down 2%, according to Bloomberg. In China, iron ore and steel futures traded limit down. Oil is softer again after the EIA reported a drop in crude stockpiles in the latest week, 930,000 barrels, when a far bigger drop as forecast (2.9 million). The FT reports “At 527.8m barrels, US crude oil inventories are near record highs.” In equities, everyone is marveling at the rally in the EuroStoxx 50 to a 20-month high—and noting that European equities are outperforming the US.

In other news, Puerto Rico, a territory and not a state, is filing for a special kind of bankruptcy. It’s $73 billion in the hole, of which $12 is insured. The WSJ compares that to Detroit with $18 billion. Municipal bankruptcy laws do not apply to PR and the special congress-appointed board is trying a different law that has never been tested. This promises to be lengthy and miserable. The losers are mutual funds and hedge funds.

• In China, the Caixin service PMI fell to 51.5 from 52.2, the weakest in a year. The composite fell to 51.2 from 52.1, the lowest in 11 months.

• In the UK, the services PMI rose to 55.8 from 55.0 when a drop was expected and the composite rose to 56.2 from 54.8 (revised).

• In the eurozone, the services PMI rose to 56.4 from 56.2 in the flash and 56.0 in March, a new multiyear high. The composite rose to 56.8 from 56.7 in the flash and 56.4 in March. Germany got 55.4 vs. flash 54.7), and Italy surprised with 65.2 from 52.9 and the composite at 56.8 from 54.1. Spain’s services PMI rose to 57.8 from 57.4, with the composite up to 57.3 from 56.8.

• Also in the eurozone, March retail sales rose 0.3% m/m and 2.3% y/y for the best reading since last October.


The euro continues to trade inside the triangle but is pushing against resistance at around 1.0940 with a high of 1.0936, after hitting support late yesterday in the US session and actually breaking it during the Asian session. The “target” is the last intermediate high at 1.0951 from April 26, which was the highest since last November (1.0954).

The Main Event The Reuters 10-year yield index closed at 2.309% from 2.296% the day before but on a lower low. At least the close is little over the 20-day. It’s quoted at 2.343% this morning from 2.299% yesterday morning. Market News reports “Ten-year U.S. yields continued to struggle to move above the 2.29%-2.32% pivot zone, of old lows from late November, January and February. For bond bears to feel more confident in their view, 10-year U.S. yields must vault 2.42%. The 100-day moving average comes in at 2.421% and is a bit above the 55-day moving average, currently at 2.391%. More recently, the market has fretted a test of the 200-day moving average, currently at 2.094%, which is rising.”

The Bund yield is quoted higher at 0.0380% from 0.0325% the day before. Two weeks ago, it was 0.178%. Market News reports “Only April 26, Bund yields peaked at 0.396%, which was the highest since March 29, when yields peaked at 0.412%. Bund yields topped out at 0.509% March 14, the highest since Jan. 20, 2016, when yields peaked at 0.548%. The 2016 10-year Bund yield high was 0.627%, seen Jan. 4 of last year. The April 18 low near 0.156% was a new 2017 low and the lowest since Nov. 9, the day after the U.S. election, when Bund yields saw a wide 0.092% to 0.206% range.

“Bunds fell to a low yield near -0.161% Sept. 27, 2016, versus the life-time low around -0.2059% seen July 6, 2016.”

Market Outlook: 

The Fed affirmed two rate hikes this year. Recent setbacks in various data are likely temporary. The probability of the next hike coming in June rose to nearly a dead cert, at least in the Bloomberg version (97%). US yields responded appropriately, rising in every tenor except the 30-year. The US 2-year is quoted at 1.314% while the German equivalent is -0.706, giving a premium of the US over the Schatz of 2.02%, a 3-week high. The 10-year differential is 2.305% in favor of the US.

So why did the dollar fall back against the euro after the first flurry of buying? It seems perverse. But see the yields differentials vs. the currencies (from http://kshitij.com/graph-gallery/bond/currencyyield-giltbond-diff). The 10-year chart indicates a roughly parallel move in the differential and the euro/dollar. Anyone who says the correlation is weak or breaking down is not looking at this chart.

Ah, but move on the 2-year diff against the euro/dollar. Here we see the euro outpacing the differential and by a widening gap. What’s going on? First, despite some gloomy nay-sayers, the Fed was always going to stick to the scenario of three hikes this year—normalization—come hell or high water. Its credibility relies on it. And seemingly a majority of market players have already baked that into the cake, i.e., “discounted” it. Europe is a different matter. Yes, Mr. Draghi says the policy council is not even considering tapering, but the market prefers to see it well on its way by year-end. In other words, change is coming regardless of what the central bank says. Currency traders want to position themselves ahead of the news. 

Analysts point out that comparatively speaking, the eurozone is doing better than the US. GDP is up 1.7% annualized in Q1 vs. the lousy 0.7% in the US. The PMI’s are hitting multi-year highs while the US has mixed readings. Europe has rising auto sales while the US has falling sales of new cars and used-car lots stuffed to overflowing. European equities are hitting new 20-month highs and the EuroStoxx 50 is outpacing all the US indices. The Stoxx 600 is at the highest since Aug 2015. And the Dutch and probably now the French are rejecting populism/nationalism in favor sane and reasonable political leaders. Compare to the fruitcake Trump.

In sum, 2-year European yields are rising faster than the US equivalent as European traders imagine a faster pace of normalization (i.e., disbelieving the ECB) while the US has already discounted the existing pace (believing the Fed but not impressed). FX positioning favors the euro—long in advance of the events.

As for bond yields themselves, Bloomberg has a nifty story on Oxford Economics’ analyst Saroliya, who postulates that the Greenspan conundrum—excess savings—is undermining what would be the normal rise in yields. This makes sense. He also points out that sentiment bleeds from one national bond market to another so that price/yield changes are more closely correlated these days, about 67%. “Global forces look set to limit rises in long-end bond yields even for markets where there may be local reflationary impulses. A trend rise in long-end yields requires a pick-up in global trend inflation, which, our research shows, isn’t imminent.”

Here’s the comparison: “’Our analysis suggests that intuitive anchors of long-end nominal yields, such as nominal GDP growth, are alone unlikely to perform well in the current regime of large cross-border capital flows and structural forces such as the global savings glut.’ That echoes the conundrum that faced markets back in 2005, when former Fed Chairman Alan Greenspan noted swelling current account surpluses in China and the Gulf were driving a decline in long-term yields and defying a series of policy rate hikes.”

So, want to know why bond yields are sticky? Blame the savings glut. And US yields are stickier than European yields.

A distinct dollar negativity may get more thrust. Friday’s payrolls can always bring another unhappy surprise. The forecasts from the usual suspects are clustered around 180,000-190,000. Reuters has
185,000. As usual, a miss by a mile, as we saw in March, would be wildly dollar-negative. Even an exact hit, while probably triggering a dollar spike high, will disappoint in the end. It would take a thundering overshoot (such as 250,000) to provide the dollar an underpinning.

Euro selling because of risk aversion due to the French election continues to dissipate. Sunday brings the second round of the French election and even though we all think we know the outcome, the euro should gain when the actual news comes out. The rhetoric is getting desperate, which is fun if not useful. Bloomberg reports LePen tried to associate Macron with Islamic terrorism in the debate—straight out of the Trump playbook. Macron responded “I’m looking at the high priestess of fear-mongering.” After the debate Monday night, a pollster gave 63% to Macron and 34% to LePen. Overall, Bloomberg’s aggregation of French polls gets 60% for Macron and 40% for LePen.

Quartz reports the French election polls halts the scary idea that Brexit and Trump were the start of a really bad trend. “… Le Pen is much further behind than Brexit and Trump were at similar stages in the campaign. To win, Le Pen would have to close an 18-point lead with rival Emmanuel Macron—a swing of several million votes—in just a few days. Pollsters say it can’t be done.” The chart is compelling. Let’s hope it’s accurate.

A final note about inflation: rising oil prices encourage the viewpoint that inflation is hot on its heels. But it’s just not happening. The FT reports that oil is languishing near $50, in part on recognition that “For all Opec’s self-imposed production restraint, the group’s exports have fallen by less than their output cuts might imply. Morgan Stanley analysts say that while Opec has hit its target by cutting as much as 1.4m barrels a day of output to try and support the market, shipping data suggests the group’s exports have declined by less than 1m b/d since the start of the year.”

Other agrees. The market is losing faith in OPEC in part because it’s being “disingenuous” about the difference between output and exports. They may be producing less, as promised, but they are shipping more from storage. In other words, cheating, as OPEC members have always done. OPEC meets again on May 25 to rubber-stamp continuation of the output cut, but by then, wider examination of export data may have undercut confidence in OPEC to the point of irrelevance. Or not. Morgan Stanley is keeping the faith. Exports were already slowing in April.

Political Tidbit: Trump is pushing yet another repeal-and-replace health care bill and it may come up for a vote today—without the usual Congessional Budget Office ”scoring” that details who gains and who loses what. Trump meets Australian PM Turnbull today. Commentators are still reeling from yesterday’s outrage—Trump saying he can’t see the reason why peace in the Middle East is not easily achievable. How embarrassing. He is friendly to Hamas—and to Netanyahu. Worse is Trump’s idea that the Constitution is “archaic.” And worse yet is the latest count of outright lies Trump has told in the first 100+ days in office—over 400, including Obama surveilling Trump Tower. This is not getting any better.

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